Description

Chapter 1 - Business environment
Confidence has returned to real estate markets and Europe is once again the place to do business.

Chapter 2 - Real capital markets
Allocations to prime real estate among European debt providers and equity investors are expected to continue rising in a sustained, albeit gradual, opening up of capital markets over 2014.

Chapter 3 - Markets to watch
Recovery is under way, and investments are back on track. That’s the message that the European real estate industry is sending this year. (Chapter 3 includes the following article: Demographic ageing is changing our society. We read all about the consequences of this trend for our health and pension systems. But what do population changes have in store for real estate markets? Professor Dirk Brounen explores European cities in search of an answer.)

Chapter 4 - Green futures
Three years ago, sustainability made its way into Emerging Trends Europe as a brief footnote, as most interviewees dismissed its economic function. But between then and now, the industry has come a long way.

Executive summary Executive summary That said, Europe’s real estate industry is staying sober: ‘safety-first’ remains the mantra. Trophy buildings and core properties in London, Paris and Germany’s “Big 5” cities will still be sought by investors with deep pockets and long time horizons – many of them foreign. Lenders, too, have no qualms about financing these assets. Europe’s real estate industry expects more and better in 2014. It is more confident about its prospects and its ability to improve profits. Headcounts, too, have a better chance of growing. This belief is spread widely across the continent. Europe’s economy is growing, and political uncertainty over its future declining. Ireland is seen to be improving; Southern Europe is thought to be past the worst. Equity is flowing in, and debt is becoming easier to find – though how much easier depends on where and for what. Risk, too, is no longer a dirty word. As Europe’s economy improves, the real estate industry is venturing out of its bunker. It is moving into areas that last year would have been regarded as no-go: Spain, Tier 2 cities, less-thanprime buildings in Tier 1 cities, development and adventurous alternatives, such as student housing, data centres and real estate debt. This dichotomy between ‘risk-on’ and ‘safety-first’ shows up in the ratings respondents to Emerging Trends Europe’s survey give cities for their 2014 prospects. Munich is ranked Number 1 for existing investments – followed by Dublin. And Dublin took first place for new investment, while Madrid, Barcelona and Athens, which were at the bottom of the prospects league last year, are ranked mid-table for 2014. And intriguingly, as Europe pulls out of recession, the green agenda is emerging as a significant factor. This year, for the first time, Emerging Trends Europe asked the industry some pointed questions about sustainability. We received some revealing answers: three-quarters of respondents include sustainability in their business strategy. This movement is partly down to the battle for prime assets. Global capital is flowing into Europe and competition for the best buildings in the best locations of its gateway cities is intense. The time has come to look further afield, to other markets where prices and lot sizes are more digestible. And equally important, debt too is now starting to be available for these assets. Some of this greening is down to the push factor of increased regulation. But there is also a pull factor: firms see that sustainability makes business sense, mitigating obsolescence and attracting tenants – and capital. Nowhere is the change of mood more striking than in the industry’s willingness to contemplate investing in Southern Europe, and Spain in particular. Last year, Emerging Trends Europe earmarked Spain as a market to watch, but the switch from “no-go” to “good opportunity” has been surprisingly rapid. In real estate 2.0, success will be not only about choosing the right assets and managing them well, but also about knowing what drives the market – demographics, regulation, changing technology and changing lifestyles. As one of this year’s interviewees puts it, “How you get value is not about just bricks and mortar but the function of the real estate.” Emerging Trends in Real Estate® Europe 2014 1

Business environment Confidence has returned to real estate markets and Europe is once again the place to do business. Half of those surveyed expect to better their profits in 2014, and very few – 6 percent – expect to do worse. The most bullish about their business in 2014 are respondents in Ireland, Central & Eastern Europe, and the UK, while fewer of those in Southern Europe – Spain, Italy, Portugal and Greece – are expecting profits to grow (see Figure 2). Benelux and Switzerland are also more downbeat. Allocations to real estate are increasing and investment activity is gathering momentum in core markets. But just as importantly, there are clear signs it is spreading to regional cities. And increasingly, development is seen as a viable option for investors. 53% expect to better their profits in 2014. But concerns over political uncertainty and a potential dismantling of the eurozone – such a corrosive backdrop to previous surveys – have eased, at least for the time being (see Figure 3) and more than half the respondents believe Europe’s economy will improve. Emerging Trends Europe’s survey reflects an improving business environment and the prospect of higher profitability and headcount for 2014, with only isolated pockets of gloom (see Figure 1). Figure 1 Business prospects in 2014 2014 2013 2014 54 41 56 36 53 41 46 36 % 6 % 42 12 55 % 9 % Business headcount 33 Increase 50 Stay the same Decrease Note: Percentages may not total 100 due to rounding. Source: Emerging Trends Europe survey 2014 Emerging Trends in Real Estate® Europe 2014 9 Business profitability 2014 2 % Business confidence 2013 2013 6 17 %

Chapter 1: Business environment They suggest that the recovery, though gradual and fragile, will carry with it some rental growth, which has been the missing ingredient in the investment mix. “The only way the capital markets side can be sustained is if it is moving together with occupier demand,” says one interviewee. Figure 2 Business profitability in 2014 100 67 65 56 55 54 50 40 36 33 Increase % Ireland Stay the same 33 33 41 45 35 50 50 47 France 10 17 2 Decrease Central & Eastern Europe UK 3 12 Germany Nordic Russia & region Turkey 56 % 11 Southern Europe Benelux Switzerland Source: Emerging Trends Europe survey 2014 Figure 3 European business environment in 2014 53 17 Improve 16 13 % Stay the same Get worse 42 57 62 64 However, the cost of finance remains an issue for many respondents (see Figure 4). Short- and long-term market rates are expected to rise in 2014, although there is a widespread belief that political leaders and central banks will keep base rates at historic lows to support economic growth. “We are more optimistic for Europe than for some considerable time,” says the CEO of a global advisory firm. “We have seen a material pick-up in our business in the last six months; not across the board but even the slower markets – Southern Europe and the Nordics – have stabilised and started to improve. The core markets of the UK, Germany and France have picked up strongly. This is due to a lot more money coming into the market from investors.” It says something, too, about the improving conditions and confidence that the biggest perceived issue facing the industry is a shortage of suitable assets to buy (see Figure 4). That in itself is prompting many to be bolder when it comes to their strategy for 2014. As one pan-European fund manager says: “There remains an appetite for yield but the economic backdrop is inviting investors to consider more positively putting more risk on the table.” 5 The European economy % 26 Availability of prime assets 22 Cost of finance 24 Political uncertainty Source: Emerging Trends Europe survey 2014 Emerging Trends in Real Estate® Europe 2014 3

Equity gush Direct investment in European real estate is “almost back at the pre-crisis level” and the impetus is attributable to sovereign wealth fund capital, much of it from Asia. Interviewees and respondents to the survey are as one in proclaiming the continuing dominance of the sovereign wealth funds and their flow of capital into core property. “We’re optimistic that Figure 4 Issues impacting business in 2014 34 37 18 11 % these new sources of capital – a lot of which are recycled savings from emerging markets that are doing quite well – need to diversify and invest overseas,” says one interviewee. “There is so much Asian capital coming into Europe,” says a pan-European fund manager, “even if you pick up a small bit of this capital it’s actually very significant for you as an individual fund manager.” Nearly 80 percent of respondents believe that capital from Asia-Pacific will increase during 2014. The other big capital source is the Americas, and here two-thirds of survey respondents expect an increase of funding in 2014 (see Figure 5). Shortage of suitable assets to acquire 26 40 27 7 % Cost of finance 25 42 28 5 % Regulation 19 33 32 17 % Sales of assets forced by lenders 10 39 39 12 % Sustainability Significant Moderate Low No effect Source: Emerging Trends Europe survey 2014 Figure 5 Cross-border capital into European real estate in 2014 3 9 15 1 8 11 3 19 % 23 Asia-Pacific % % The Americas Europe 53 56 64 Significantly increase Increase Stay the same Source: Emerging Trends Europe survey 2014 4 Emerging Trends in Real Estate® Europe 2014 Decrease Significantly decrease 36 There are encouraging signs that this strengthening of cross-border flows has emboldened domestic institutions, especially in the UK, which remains Europe’s biggest and most liquid investment market. “The UK is still dominated by non-domestic providers of equity but as far as UK institutional money is concerned, that tap is starting to be turned back on,” says one interviewee.

“It remains hard,” says one European investment manager. “People are concerned about investing new money until they have got their old money back. Fund managers have not been returning a lot of old money because they feel values are still going up – so it’s a bit of a catch-22. But things have improved materially from years past and at least investors are now willing to consider investing in an illiquid real estate fund.” This view is supported by Real Capital Analytics, which reports that the first three-quarters of 2013 saw investment activity across Europe increase 10.5 percent to €110.9 billion, with the UK accounting for €34.5 billion (see Figure 6). Domestic UK investors placed 90 percent more capital in Q3 than in Q2. Interviewees and respondents across many European markets say that raising equity finance is not easy, as such, but it is easier than a year ago. “But always you need to have a good product,” says one Polish asset manager with a Central & Eastern Europe remit. Indeed, “quality” will prevail, even in one-time no-go areas such as Greece. “If the right opportunity arises, there is a perception that equity capital will be around to fund it,” says a Greek interviewee. Debt on the mend Europe’s debt providers are similarly more willing to lend to property. Between them, the banks, insurers, debt funds and other alternative lenders are ensuring that Europe’s debt market is “improving with each passing month”, albeit still “a shadow of its former self”. “This year Figure 6 Real estate investment in Europe, Q1–Q3 2013 billion Norway Sweden €2 UK €35 Ireland €2 France €12 Spain €2 Russia Netherlands €3 €1 €7 Denmark Poland Germany €2 €26 Czech Republic €1 Austria Switzerland €1 €1 Italy €3 Source: Real Capital Analytics 6 Emerging Trends in Real Estate® Europe 2014 Even so, there are mixed feelings towards the new breed of lenders. Powerful groups such as insurers Allianz and AXA have been welcomed for “filling in some of the gap and creating a competitive environment”. So too are the specialist debt funds, but they are “too expensive” for some. And in a tough market such as Italy, according to one local fund manager, they are “an irrelevant market niche”. “They see a gap in the market and they’re well financed but there has never been a better deal for property companies than a bank, and thank goodness they’re still there,” says the managing director of a quoted UK company. But he adds: “The banks are going to be very difficult lenders to real estate over the next two to three years, and particularly hard for private companies.” Other €5 there is more lending and the margins are improving. I do see it carrying on because the policy makers want to see it carry on and breathe life into moribund markets. But it’s hard to get more than 60-65 percent leverage.” €6 UK and German banks in particular are expected to originate more real estate debt in 2014, which reflects their positive view on the market. “We definitely consider ourselves in the growth phase,” says the property director of one UK bank. According to the CEO of a multinational REIT: “If the product is good enough, equity will be there. And the banks are just like investors. When they come back into the market, they will focus first on the quality assets before going for the more time-consuming and tricky deals.”

Chapter 1: Business environment Prime assets are over-priced 17% Strongly agree 42% Agree slightly 19% 21% Neither agree nor disagree Disagree slightly Battle for assets As investors increase their allocations to property, there has been a “huge capital push” into core European markets, which will continue through 2014. The implications are many and varied. Interviewees and survey respondents talk of “pricing bubbles” and “markets overheating” – the language of the pre-financial crisis era. This is a cause for concern for some and an opportunity for others. “We’ve seen prices go up and I think they have a little farther to go but eventually the markets are not going to make sense. Certain markets, like London and Germany, are starting to reach a critical point,” says one lender. “Some of the investors from the US and Asia are investing in big lot sizes in markets that they may not have spent much time in at all. There will be some miscalculations when you have that much money chasing something that is of limited supply.” Jones Lang LaSalle’s pan-Europe forecast for prime capital values in 2014 is a more sober 4 percent growth for offices, 1 percent for industrial and 4 percent for unit shops. Low Euribor and Libor rates provide the backdrop to this modest growth and some – by no means all – respondents expect a rise in 2014. “We are starting to see pressure in the bond markets and this will affect swap rates,” says one UK interviewee. “However it would have to be a meteoric rise to start changing the 1% Strongly disagree direction and velocity of the marketplace. Real estate is still seen as a good diversifier and a good way of getting dividend, and I don’t see that changing.” The big unknown, though, is occupier demand. “Until we see strong rental growth returning I don’t think we’ll see a lot more movement in capital values.” One global fund manager says: “If there is a risk scenario today it is that capital flows may be getting ahead of underlying fundamentals. In a lot of markets there is limited rental growth but capital is available to buy.” Others are far more sanguine about the weight of capital on core markets. “The most important impact is that it absolutely locks in demand for quality product,” says the director of one REIT. “The large, global investors are looking for predictable, secure, long-term returns and as a consequence they’re looking for high-quality product. They’re not looking to make a 40 percent return in one year but a steady 7 or 8 percent year after year. That locks in support for pricing, which is relevant to our business.” According to others, many of the sovereign wealth funds also “lock assets up for a long time”, which is at odds with the normal trading patterns of domestic investors. Either way, with a quarter of all survey respondents predicting a fall in the availability of prime assets during 2014, something has to give. Across Europe, many domestic institutions and some of the smaller cross-border investors are increasingly looking beyond the main markets and bidding for good income-producing assets in regional cities. “London is fairly fully priced and now needs rental growth to deliver returns,” says a UK interviewee. “Because of that a lot of the UK institutions are going into the regions again. That’s a big improvement in the market – one thing that has been missing – and it will broaden.” “We’ve been buying in Stuttgart rather than Munich and getting 6.5 percent yield rather than 4 percent. For that kind of office stock we’ve seen steady uplift,” says a pan-European fund manager. Others are moving still further up the risk curve. “There’s an opportunity to progress and put more money into development over the coming year.” Though increasing debt availability is enabling developers and investors “to gear up across an increasing risk spectrum and geographies” it remains under control, insists a global investment banker. “There is not the same amount of leverage. All this capital that has gone into the sector has gone in with much lower debt, which means it is going to be a much more stable environment.” Yet this same search for value and yield – as well as diversification – is taking increasing numbers of mainstream investors into alternative asset classes, such as data centres and student accommodation. The latter is part of a bigger, positive shift in sentiment towards residential investment, which remarkably is judged to have better prospects than core commercial real estate for 2014. Emerging Trends in Real Estate® Europe 2014 7

“It seems very clear that capital – debt as well as equity – is looking at a much broader range of assets than was the case even a year ago,” concludes one interviewee. “That’s partly down to the competition for prime assets and how difficult finding value there has become. This is good news, because towns and cities outside the prime centres have been starved of the capital investment they need over the last five or six years.” 75% Next stop… Spain The extraordinary turnaround in sentiment towards Spain is one of the most remarkable property stories of this year’s Emerging Trends Europe. Within weeks of the country’s bad bank, Sareb, opening for business last summer, the rush of opportunistic investors into Madrid and Barcelona had turned into a veritable stampede. By the autumn, Spain’s transformation from property pariah to star market was complete. By all accounts, the revival is expected to continue in much the same vein in 2014. have a sustainability strategy in place. “As we have seen with Ireland, 24 months ago no-one wanted to know. Now it’s the darling of the market,” says one interviewee. “There is way too much capital chasing product in Ireland and that’s why Spain will also recover because all the investors in Ireland have moved down to Madrid.” There are now good buying opportunities in Spain 10% Strongly agree 57% 8 Emerging Trends in Real Estate® Europe 2014 17% Neither agree nor disagree Agree slightly 14% Disagree slightly 2% Strongly disagree One pan-European fund manager believes mainstream institutions will be giving the opportunistic investors a run for their money in Spain before too long. “We think that it is a medium term play rather than immediate – but it is coming back. You will see one or two benchmark deals, which gives confidence for others to go in on the best stock in the best locations.” Some believe that one of those benchmark deals took place as early as last autumn when leading UK-listed shopping centre owner Intu and the Canadian Pension Plan Investment Board paid €162 millon for Parque Principado mall in Oviedo, northern Spain. However, there are also many dissenting voices who say Spain remains a distressed market rather than anything more sustainable. Though the investment volume for the first three-quarters of 2013 soared 198 percent, according to Real Capital Analytics, it was off a very low base – the total was just €2.4 billion. Debt, meanwhile, remains extremely hard to come by in Spain. The sceptics also argue that the disconnect between capital flows and occupier demand and rental growth is more extreme here than anywhere else in Europe. “It remains a dangerous market to be investing a huge amount in before there are some signs of growth, and at the moment that’s pretty anaemic.” And according to one pan-European fund manager, the risk of Spain leaving the eurozone is still pertinent. “Even if it is a small probability, it’s a small probability of a gigantic thing happening and you will lose 30 percent of the value of your property and income overnight, and you’ll never get it back. I just don’t think the Euro crisis is in any way over.”

Chapter 1: Business environment Sustainability matters The business case for sustainable real estate is starting to take hold across the industry, six years on from the financial crisis. Over three-quarters of survey respondents have a sustainability strategy in place, but no longer solely to comply with domestic and EU regulations. In the post-crisis marketplace, there is growing recognition that green buildings form part of “a consolidation of quality” and therefore “a winning differentiator” in the eyes of potential occupiers. “Sustainability will matter increasingly both in terms of getting tenants to commit to a building for a longer time and with the end-investment value,” says the CEO of a global investment firm. Half Emerging Trends Europe’s respondents believe that going green has led to them achieving higher rents, which is arguably one of the most extraordinary results in the survey and hard to have envisaged in previous years. As one interviewee observes, “The risk is if you have a property that’s no longer viewed as modern or green you could see your effective rent drop 30 to 50 percent. It is not just a matter of rent… covenant quality will drop too.” Even those who remain unconvinced that there is a strict correlation between sustainability and rents, recognise that green buildings offer protection from obsolescence while keeping operational costs in check. Drill down to demographics possibilities of sustainability at their peril. It appears that in its search for value, sustainability represents one more, increasingly important, business opportunity for the industry. Best bets Seek out assets in fast-growing secondary locations and larger, regional cities Pricing of core properties looks increasingly prohibitive, but there is still good value to be found for high-quality, income-producing assets on the fringes of the CBD or in the larger regional cities. Many of these markets benefit from solid and diverse economies. The next phase of the cycle will likely see occupiers relocate to these areas, a movement that should support growth in rents and values. Sign up for Spain but follow the tourist dollar Spain comes with a health warning, but investment momentum is building. Opportunity funds will feast on distressed assets; investors with a longer view can take heart from the recent significant rise in tourism numbers and the fact that a lot of investment in infrastructure has already been made. Retail, hotel and leisure sectors are worth considering. Get smart with sustainability Corporate occupiers will toughen their stance on sustainability, leaving many buildings falling short on green credentials and ultimately obsolete, even in prime locations. Smarter investors have already traded out their more challenging assets. But there are still opportunities to sell such stock to opportunistic investors that are after a short-term yield play or retrofitting. Europe’s population is changing, with important consequences for real estate. Aging baby boomers will need more healthcare and retirement homes, while Generation Y – the under-30s – has different expectations and lifestyles to their parents’. Independent and techsavvy, they want workplaces that are open and allow tele-commuting and hotelling; they’re not keen on owning houses in distant suburbs, preferring to rent in urban cores or “urban-light” suburbs that offer good transport and a social hub. Understanding these changing patterns – in countries, cities, neighbourhoods and buildings – will give investors and developers an edge. Explore alternatives Real estate is moving beyond offices, retail and industrial to sectors that offer good yields and stable income streams that are not pro-cyclical: student housing, healthcare, retirement homes. Debt too is becoming mainstream. But beware: these require operating expertise and scale. Consider co-investment The competition for assets is so intense in key sectors that there is a high risk of failing to execute the deal on any asset that comes on the market. Hooking up with a local partner will mean relinquishing some control, but can provide superior market intelligence about assets to target and avoid, as well as a head start on the competition. In any event, the common view among respondents and interviewees is that investors and developers play down the Emerging Trends in Real Estate® Europe 2014 9

Real estate capital markets Allocations to prime real estate among European debt providers and equity investors are expected to continue rising in a sustained, albeit gradual, opening up of capital markets over 2014. Figure 1 Availability of equity and debt in 2014 Equity for refinancing or new investment Substantially less 1% Moderately less 8% Substantially greater 14% The same 21% Moderately greater 57% Debt for refinancing or new investment Substantially less 4% Substantially greater 8% Moderately less 11% The same 34% Source: Emerging Trends Europe survey 2014 10 Emerging Trends in Real Estate® Europe 2014 Moderately greater 43% The real estate sector is in “expansionist mode” when it comes to core markets, with both lenders and investors playing their part. “It’s still taking an inordinate amount of time to get things done because of where we’ve come from,” says one pan-European investment manager, “but activity is up and I anticipate it accelerating.” Securing debt and equity may take time, but at least the tap has been turned on (see Figure 1). Emerging Trends Europe’s survey shows a significant upturn in expectations for 2014. More than 50 percent of respondents say availability of debt for refinancing or new investments will be moderately or substantially greater. For equity, they strike an even more bullish note with nearly threequarters expecting greater availability. Such sentiment is in stark contrast to last year when much of the industry was “off limits” to capital markets. And yet the improvement owes little to underlying economics or occupier demand. As one institutional fund manager says, “This scenario is not about the prospect of immediate or, in some cases, even medium-term rental growth. This is about weight of money and relative pricing of real estate compared to other asset classes.” Another concludes: “Now people are gaining a little confidence, they can tolerate some illiquidity. Property is seen as one of the few remaining asset classes that look relatively high yielding for relatively low risk.”

Debt dials up Debt is the lifeblood of property, and it is starting to flow across Europe. Though no-one is getting carried away, the balance of expectations in favour of more debt availability in 2014 is evident in most of the countries and regions surveyed. The UK is clearly most upbeat about access to debt with nearly 90 percent of its respondents forecasting greater availability. But all the major markets – including Germany, France and the Nordics – are positive (see Figure 2). “A lot of traditional lenders are progressively returning to the market and increasing their allocations to property, providing it is not too highly geared – 50 to 65 percent loan to value on the right assets and the right customer,” says one interviewee. “It is not easy to get it but it is possible.” Ireland’s increasingly vibrant investment market, meanwhile, is reflected in the fact that all of its respondents anticipate the same or more debt this year. A similarly optimistic mood pervades Central & Eastern Europe, where half those surveyed believe the lenders will be more generous than a year ago. This largess doesn’t extend too far, however. Banks are still “very strict” on whom they will lend to. “Listed property companies have survived well with their banks but private companies are still really struggling and will continue to do so.” Elsewhere, the outlook is mixed. Unsurprisingly, Portugal, Italy, Greece and Spain are less positive than the rest of Europe, while a significant number of respondents in the Benelux countries – 27 percent – believe the availability of debt will fall in the coming year. There is widespread acknowledgement, meanwhile, that those German banks “that survived cleanly” are once again a big influence. “The German banks are out like a storm now, their budgets are significant. They are doing a lot of financing and they are chasing a lot of deals,” says one interviewee. But behind the headline results, the European debt story is full of nuances and varied experiences for borrowers. The robust credit ratings of the major, publicly quoted real estate investment trusts (REITs) have ensured “a tremendous reception” when they have tapped the corporate bond market. But they also still rely heavily on their banks, and those relationships remain, by and large, strong and productive. Access to debt is “disturbingly easy”, according to one UK REIT. Banks elsewhere, however, remain “schizophrenic” as they continue grappling with “conflicting pressures to lend more and shrink their balance sheets”. Consequently, they tend to be “friendlier” towards investments and projects in their home countries. Figure 2 Availability of debt across Europe in 2014 68% 67% 57% 52% 48% 42% 33% 17% 12% 2% UK 25% Central & Eastern Europe Substantially greater 0 0 Nordic region Ireland Moderately greater 5% 0 France 0 The same Source: Emerging Trends Europe survey 2014 12 8% 3% 0 Emerging Trends in Real Estate® Europe 2014 29% 21% 19% 14% 13% 8% 0 22% 14% 14% 36% 31% 31% 29% 18% 48% 47% 40% Moderately less 0 8% 1% 3% Germany Substantially less 3% 2% Benelux 6% Southern Europe 0 Russia & Turkey

Chapter 2: Real estate capital markets The survey results are correspondingly mixed. Nearly 80 percent of respondents believe the provision of debt by the banks will stay the same or increase in 2014. But 22 percent predict a fall (see Figure 3). Figure 3 Sources of debt in 2014 9 61 25 1 % 4 Debt funds, insurers and other non-bank lenders 2 37 40 19 3 % Banks Significantly increase Increase Stay the same Decrease Significantly decrease Source: Emerging Trends Europe survey 2014 Figure 4 Ability to secure senior debt in 2013 compared to previous year 17 45 32 1 % 5 New prime investments 9 46 33 1 % 10 Refinancing existing investments 7 32 44 12 5 % Development 5 35 40 16 New secondary investments Improved significantly Improved somewhat Deteriorated somewhat Deteriorated significantly Source: Emerging Trends Europe survey 2014 Stay the same 4 % The funding gap is being partly filled by specialist funds and a strategic expansion by insurers into debt finance. According to Preqin, there were 17 Europe-focused debt funds in the market, targeting $US12.4 billion in August 2013. Borrowers are benefitting from the increasing competition and that trend looks set to strengthen in 2014. Some are wary of debt funds: “They will be the fastest flash in the pan. Most of them will be gone in two to three years because the returns they have promised people will turn out to have been ephemeral. They are a short term opportunity.” There are signs, meanwhile, that commercial mortgage-backed securities (CMBS) is re-emerging as a source of debt in Europe. Last year’s issuance leapt to €5.4 billion, boosted by investors’ enthusiasm for bonds backed by German multi-family housing. Nearly half the survey respondents believe CMBS will increase in 2014. Over half the respondents say their ability to refinance existing investments with senior debt improved during 2013, and nearly two-thirds found it easier to fund acquisitions of prime stock (see Figure 4). However, securing finance for development and new secondary investments remains problematic. “There is more competition among lenders and that is affecting spreads and margins on transactions,” says one pan-European investor. “There is availability of debt for the best quality, income-producing assets in the better locations. But you don’t have to move far from that and you get a significant thinning of the market.” Emerging Trends in Real Estate® Europe 2014 13

Equity escalates Ever-increasing equity is being pumped into European real estate, but this is by no means an even distribution of money – there’s a clear trend towards “a polarisation of capital-raising”. Though institutional investors are increasing their allocations to the asset class, they are no less demanding than before. As one pan-European investment manager puts it, if there are 100 fund managers in Europe, 20 are raising money and 80 are not. This is not just about track record and performance but investors “trusting” their managers to be appropriately staffed to manage assets in all jurisdictions, and not to operate simply as financial allocators of capital. “That’s why we have seen and will continue to see some fund management platforms being sold. They are running out of money because they have significant operating losses because of the climate we’re in, or they cannot raise any new equity.” Although fundraising remains challenging, some strategies are having more success in attracting capital (see Figure 5). Debt funds are extremely popular with investors. The real estate funding gap in Europe has opened the door for these new lenders, who can offer investors asset-backed yields that are higher than what they are getting on other debt. It is not just about performance; investors need to be convinced that there is “a good investment story”, which is why some managers of discretionary pooled funds are also struggling to raise equity. “It depends on what you are trying to do,” says one interviewee. “If you have a project or an individual asset that needs fresh capital, it is a little easier. If you are trying to raise a new fund there is still very little institutional capital available.” Those principles apply equally to leading REITs, all of which exude the same confidence as the heavyweight investment managers. Shareholders “don’t like the idea of raising money in a blind pool”, but if there is a specific project or corporate acquisition then “you’re potentially pushing against an open door”. In 2014, there will be selected, targeted equity raises “in the 10% cash box style” from companies who are keen to pursue opportunities and take investors with them. say there will be more equity in 2014. Thus, both the fund management community and property companies are dividing into the ‘haves’ and the ‘have nots’. Says one pan-European fund manager: “We’ve raised equity successfully over the last couple of years but nowhere near the amount we wanted, and we got it from seven different countries. You’ve got to go far and wide for it, and work hard for it. And that will continue.” Figure 5 apital raised by private equity funds for European real estate in 2013 C Core 0.8 Opportunistic funds, too, are raising significant sums to spend in Europe from investors, particularly US institutions, who have decided that markets here have bottomed out. But track record is critical; capital flows to the big, established brands or boutique players who have proved their worth. Opportunistic 3.2 Value added 0.8 €bn Core-plus 0.8 Debt 2.6 Source: Preqin 14 71% Emerging Trends in Real Estate® Europe 2014

Risk on With greater access to debt and equity has come “an enormous capital push” into European real estate, which interviewees anticipate will translate into a 10–15 percent rise in investment volumes in 2014. “The sense out in the marketplace is that Europe is where the value is going to be in the coming years,” says one global adviser. “We’re expecting to see more equity coming into the sector across Europe in a publicly listed form, either through IPOs or just companies raising capital. We see the main focus, still, as the UK and Germany.” As far as sovereign capital from Asia and the Middle East goes, the main beneficiary to date has been London, where interviewees talk of “£8 of equity for every £1 of available property”, a potential price bubble in the making and therefore a broadening search for value (see Figure 6). “A year ago people thought the eurozone was going to dismantle and that we would have a two-speed eurozone,” says one fund manager. “But now that the perception of currency risk is lower, that may mean some of this global capital will find its way into quality assets in the major German and French cities.” There are now good buying opportunities in Ireland 5% Strongly agree 46% Agree slightly 28% Neither agree nor disagree The US money is not alone. Nearly 60 percent of respondents to the Emerging Trends Europe survey believe that prime assets are overpriced. This chimes with research by Real Capital Analytics, showing the start of a shift by global and European investors in 2013 from ‘Tier 1’ cities like London and Paris to ‘Tier 2’ cities such as Frankfurt and Stockholm (see Figure 6). This movement of investors up the risk curve will gather momentum in 2014. “If we were bidding on assets 12 months ago, chances were that we were the only bidders,” says one UK fund manager, who has been buying regional real estate for five years. “Now you can have 12 or Disagree slightly 6% Strongly disagree so bids for the same kind of assets. It has become highly competitive and yields are coming down quite rapidly.” Development is another route up the risk curve, and 71 percent of respondents to the survey regard it as an attractive means to an end product (see Figure 7). “Core property has become increasingly expensive so if you can manufacture to core you feel highly optimistic about your ability to sell,” says one interviewee. “For quality, income-producing property in major markets, the demand continues to grow. We’re doing projects in London and we feel pretty confident about selling them.” Figure 6 Europe’s ten most active real estate markets, Q1–Q3 2013 Billions €20 London €8 Paris €4 Berlin-Brandenburg €4 It is just as likely, however, that this search will lead investors beyond prime markets. As one interviewee says, “US money tends not to play in London”, because it is too expensive, but will instead invest in quality secondary in the regions. Moscow €3 Frankfurt/Rhine-Main €3 Munich €3 Rhine-Ruhr €3 Stockholm €2 Amsterdam/Randstad €2 Hamburg Source: Real Capital Analytics 16 15% Emerging Trends in Real Estate® Europe 2014

Chapter 2: Real estate capital markets Figure 7 evelopment is an attractive way to acquire D prime assets 15% Strongly agree 56% Agree 18% Neither agree nor disagree 10% Disagree 1% Strongly disagree Source: Emerging Trends Europe survey 2014 Spanish surge But the biggest revelation is the capital movement into Spain, which has turned that market from “zero to hero overnight”. It is not so much a search for value as “a lemming-like” scramble, according to some sceptics. Investors have shrugged off any fears of a eurozone break-up and alighted in Madrid and Barcelona, following the establishment of Spain’s bad bank Sareb in summer 2013. For many it is a rerun of what went on earlier in Ireland and that country’s National Asset Management Agency. “It is about the opportunities becoming unlocked with the whole banking sector dealing with its portfolios and loans issues,” says one interviewee. “The difference with Spain is that it has been so fast.” A pan-European fund manager says: “A lot of the American distressed-bond, value-driven arbitrage funds – who often don’t do real estate – are not finding enough arbitrage and distress in America, and so they’re over here. Will their interest continue through 2014? Definitely.” 39% say there was more debt for development in 2013. Another interviewee concludes: “My concern is that this is driven by the buy-side rather than sell-side. I do expect to see quite a lot of deals done in 2014. But in five years’ time, I think people will look back and see this as one of those experiences they would rather not talk about.” Emerging Trends in Real Estate® Europe 2014 17

Attractive alternatives Figure 8 Sector investment prospects 2014 Quality of income is paramount for many investors in their search for value, which is one reason why both the investment and development prospects for student housing are judged to be better than any other property asset class in this year’s survey (see Figure 8). 22 59 14 4 2 Student housing 20 60 10 5 5 Data centres 19 Healthcare Purpose-built student accommodation exhibits some of the same benefits that draw global and institutional investors into mainstream commercial real estate: the opportunity to invest at scale, allied to long-lease income and covenant strength. 54 22 19 47 8 25 5 1 Private sector residential rental 26 40 26 9 Serviced apartments 22 44 22 9 3 Retirement living With growing numbers of overseas students descending on leading universities across Europe, the market dynamics are only getting better. As one interviewee suggests, student housing is “a product that is needed in France, Germany, Spain and Italy”. 17 42 35 5 1 Logistics 9 46 33 11 1 Central city office 11 43 29 16 1 House building Even in the UK – the most mature student housing market outside North America – demand far outstrips supply in many university cities, which is compelling enough to have generated about $US3 billion of investment deals a year for the past two years. US investors have led the way. 8 46 30 6 46 18 18 12 Social housing 12 39 42 7 Hotel 25 25 33 25 17 Self-storage facilities Some regard student housing as “an emerging asset class in its own right”, but it is also part of a wider capital play on residential. Private sector rental, serviced apartments, retirement living and housebuilding all rank highly in this year’s survey in a way that was inconceivable a decade ago. 11 39 41 7 3 High street shop 11 39 29 14 7 Large industrial warehouse 7 31 47 11 3 Regional shopping centre 8 The attractions of residential are many and varied across Europe and yet two markets stand out among interviewees: the UK and Germany. 27 49 13 3 Shopping centres 2 24 37 29 8 Suburban office 4 16 52 24 Business parks Very good Good Fair Source: Emerging Trends Europe survey 2014 18 16 Parking Emerging Trends in Real Estate® Europe 2014 Poor Very poor 4

Markets to watch nine years – a sharp contrast to last year, when they were among the lowest registered since 2006 (see Figure 1). Recovery is under way, and investments are back on track. That’s the message that the European real estate industry is sending this year. Optimism has returned and cities’ prospects in 2014 are deemed to be considerably improved, indicating that investors are shrugging off their worries about the economy and beginning to see the green shoots of recovery. The ratings Emerging Trends Europe’s survey produced for cities’ prospects in 2014 are sharply higher than last year’s: 3.58 for investment and 3.17 for development on average. These scores – equivalent to fair-plus and fair respectively, are among the best in Figure 1 Average city prospects, ranking out of 5 Investment 3.23 3.3 3.3 2006 2007 2008 3.08 3.28 3.28 2006 2007 2008 2.85 2.86 3.04 3.01 2.90 2009 2010 2011 2012 2013 2.65 2.51 2.85 2.68 2.59 2009 2010 2011 2012 2013 3.58 2014 Development Source: Emerging Trends Europe survey 2014 20 Emerging Trends in Real Estate® Europe 2014 3.17 2014 “The global financial crisis has been hanging around, which has been putting pressure on the market. It has taken a long time to go through the system. People are now looking forward than looking backward,” says one interviewee. Even debt-stricken Athens, which remains at the bottom of the pile for existing investment prospects and development, is posting better results this year. The city has jumped to Number 13 for new investments, signalling that some think Greece’s distress will provide opportunities. But interviewees largely agree Athens is a market they prefer to avoid for now (see Figure 2). The real surprise of this year’s survey is Dublin. The city has zoomed into first place for new investments as equity floods in, residential prices rise sharply and predictions of significant growth in the office sector abound. But Dublin is a small market compared to European favourites London and Berlin, so opportunities will be limited. The other outstanding rebound in the rankings this year is Spain, in particular Madrid and Barcelona. Interviewees are picking out Southern Europe as the place to invest, and Spain is benefiting from the size of its market and on bets that it will be the first in the region to turn around. Opportunity funds in particular are exploring Madrid and Barcelona, and deals will be forthcoming in 2014, especially as Spain’s bad bank, Sareb, puts more loans and real estate up for sale. Core investors might be more reluctant to put their toes in the water, but discussions are certainly on the go.

Chapter 3: Markets to watch The run for core in Germany is still ongoing. “There are a lot more players – clients and investors – who wouldn’t have looked two years ago but now are,” says an interviewee. “The question is how much will they actually invest.” Elsewhere in Southern Europe, Lisbon has seen its largest real estate deal in four years, but interviewees say Portugal will need more time than Spain to turn around. And while foreign investors’ interest in Italian cities such as Rome and Milan will depend on the country’s political situation, the outlook for Milan’s office market is positive. But it’s the four German cities of Berlin, Munich, Frankfurt and Hamburg that continue to garner high rankings, with Munich topping Emerging Trends Europe’s investment league for 2014. “In Germany further property price increases are likely. But it´s a question of time, how long this trend will continue,” says one interviewee. London too continues a firm favourite. Even though it has slid a bit down the investment league – and some think it too expensive – London remains key for all core players and sovereign wealth funds who value the size, liquidity and depth of its market. This intense competition for an ever-tighter supply of prime assets has propelled London to the number one spot for development prospects in 2014. In contrast, Paris is one of the biggest losers in the rankings this year. Those surveyed downgraded it to Number 14 for existing investments, and Number 17 for new ones. However, despite an uncertain political situation, the government’s flip-flops on taxation and concerns over France’s indebtness, international investors are not likely to give up on the French capital and see it as a must-have in any portfolio. We are starting to feel that we can take more risks. Prospects for existing assets in Moscow and Istanbul have dimmed slightly as well, but both cities are still well-regarded for development: Moscow is Number 4 and Istanbul Number 6. Turkey’s capital also maintains its Number 4 ranking for new investment. Warsaw’s market, the main motor of central European real estate, is faring less well. It is now considered as a core investment rather than an emerging market, and investors are starting to consider secondary markets such as Krakow or Wroclaw. Budapest continues to be on a par with Athens as investors continue to avoid the city on concerns about politics and the general economic outlook. Southern Europe will be THE topic in 2014 And although this year’s interviewees still favour London, the four German cities and perhaps Paris, the rise in prime property prices is encouraging many to look for non-core and secondary assets in those cities. The international and pan-European players among them will also eye other markets such as Southern Europe. “There is very strong demand especially from Asian investors who are increasing their exposure in Europe. But we are entering a bubble situation where investors are going to have to find markets that are in less demand and have more reasonable prices.” Emerging Trends in Real Estate® Europe 2014 21

Demographics and winning cities Demographic ageing is changing our society. We read all about the consequences of this trend for our health and pension systems. But what do population changes have in store for real estate markets? Professor Dirk Brounen explores European cities in search of an answer. Commercial real estate success is a careful outcome of adjusting supply to changes in demand. This sounds fairly simple, but the past few years have proven otherwise. More and more cities and investors suffer from the painful side-effects of what economists like to refer to as ‘disequilibrium’. After several decades of growth and market expansion, many real estate markets in Europe have entered a new era in which success and returns are no longer yielded by tapping into a growth trend. Besides the apparent effects of the recent financial and economic dismay, demographics are often identified as a demand factor that is losing momentum. Figure 3 International trends in total population Index numbers 400 350 300 200 150 100 50 1955 1957 1995 2015 1955 population = 100 World Asia Northern America Europe Source: United Nations 24 Our demographic outlook For commercial real estate markets, there is also a clear link between population growth and demand. In Figure 3, the international trends and forecasts of the United Nation’s Population Division are plotted for both past and future decades. Populations have been growing on all major continents over the past 60 years. But demographic ageing is about to change this momentum, as young generations are small in size and the elderly are about to become a larger proportion of our society. Figure 3 clearly shows that this demographic shift is most compelling in our part of the world – Europe. While Asian and North American populations continue to grow, Europe has reached its peak and is gradually transiting into a future where the annual outflow of elderly retiring from the labour force exceeds the number of youngsters that join in. 250 0 In a recent interview with Die Welt, KfW’s chief economist Jörg Zeuner discussed his concerns about the outlook that by 2030, Germany’s working population will have decreased by at least 8 percent. Zeuner calculated that this demographic trend will eventually slow down Germany’s economic growth by almost 1 percent a year. But the effects of demographics, both on economic growth and real estate dynamics, have also been acknowledged by academics. Already in 1989, Gregory Mankiw and David Weil warned about the demand effects of demographic ageing in their paper ‘The baby boom, the baby bust, and the housing market’. Emerging Trends in Real Estate® Europe 2014 2035 2055 2075

Demographics and winning cities But the end is not near just yet. This demographic decline is not the same everywhere. In parts of Europe, like Scandinavia and Turkey, population will continue to grow. Moreover, whether this demographic trend also matters to the performance of local real estate markets still needs testing. Perhaps real estate entrepreneurs will manage to incorporate these long-term trends adequately in their plans for new supply, ensuring that a decrease in demand does not result in oversupply. Figure 4 City populations and office markets Office gross returns % Office vacancy rate 2012 % 30 Population growth (past 20 years) % 1.5 To empirically test the effects of changing demographics on local real estate markets, 11 European office markets are analysed. By matching the statistics on local population trends with the Jones Lang LaSalle’s data on offices, new insights swiftly emerge. Figure 4 ranks the cities based on their population trends over the past 20 years, ranging from Budapest (-0.75% a year) to Stockholm (+1.29% a year). To assess whether population growth and decline have had any pervasive effect on the performance of the local office markets, the corresponding office returns (red) and vacancy rates (blue) are also shown. Overall, there is a positive correlation of 0.49 between population growth and office returns. The fastest growing cities – Stockholm and London – also delivered the highest office returns to investors, while in a city like Berlin, the absence of population growth coincides with weak returns to office investors. The data also tells a clear story about population trends and vacancy rates. Here, the correlation equals -0.48. 1.0 10 0.5 0 0.0 -10 City populations and office markets 20 -0.5 -20 Budapest Berlin Rome Office gross returns Warsaw Prague Madrid Office vacancy rate 2012 Vienna Amsterdam Paris London Stockholm -1.0 Population growth (past 20 years) Source: United Nations Obviously, one needs to treat the evidence from small amounts of data like this with care, but these first results indicate that growing cities face lower vacancy rates. Again, this is no surprise, but Figure 4 offers a good indication of the strength of this effect. A shrinking city like Budapest faces the highest vacancy rates in the sample, while the blue bars of vacancy rates are lowest on the right side of Figure 4. Obviously, a sample of 11 cities and 20 years does not answer all questions, but clear traces of demographic effects are to be found in European winning and losing cities. Dirk Brounen Professor of Real Estate Economics TiasNimbas Business School Tilburg University, the Netherlands Emerging Trends in Real Estate® Europe 2014 25

The cities Dublin (2) Every year, Emerging Trends Europe analyses the real estate markets in major European cities and ranks them according to their investment prospects, as shown earlier in Figure 2. This section shows how their investment prospects have changed over time, as indicated by the respondents to the survey. The number in parentheses next to the city is its ranking for existing investments in 2014, while the graph shows the prospects for existing and new investments combined since 2005. Excellent Good Dublin Fair Poor Munich (1) Very poor Investment prospects 2014 Year 05 06 07 08 09 10 11 12 13 14 Source: Emerging Trends Europe survey 2014 Excellent The Irish tiger will make a comeback in 2014 as investors plough back into Dublin, which is expected to fire ahead on recovery hopes. However, opportunities will be limited because of the size of the market. Good Fair Poor Munich Very poor Year Investment prospects 2014 05 06 07 08 09 10 11 12 13 14 Source: Emerging Trends Europe survey 2014 Munich still tops the bill for existing investments, but falls to Number 7 for new ones, down from the Number 1 position last year. Development prospects are still considered fair at Number 2 after London’s. Its fall for new investments may be down to the fact that many are beginning to see the city’s offices as just too expensive. “The focus will turn away from the German ‘big seven’ to B cities in the future.” Others have switched their attention to the outskirts rather than Munich’s prime CBD. But Munich benefits from Germany’s position as the economic strongman of Europe and continues to attract core investors who single out its “very low unemployment and lack of highquality office buildings”. It has a bustling retail market, a strong, service-based economy and a young and growing population. Dublin is by far the winner in this year’s ranking, zooming to the top spot for new investments, up from Number 15 last year. “It’s the beginning of a boom,” says one interviewee. For existing investments, Dublin placed Number 2, just behind Munich and a big leap from Number 20 last year. Ireland’s economic turnaround is gathering pace. Unemployment has fallen to its lowest level since 2009, and the government is forecasting GDP growth of 2 percent in 2014. Significantly, the IPO of Ireland’s first-ever REIT – Green REIT – raised €300 million last August; the issue was oversubscribed. A second REIT also floated at the end of 2013, raising €365 million from investors. Both are targeting commercial properties, primarily in Dublin. “Purchasers in the Irish property market have huge amounts of equity at the moment,” says an interviewee. Office prices have increased significantly over the past 12–18 months in prime locations such as the docklands, and locals are predicting a further rise of 10 percent in 2014. US and other foreign buyers have been at the forefront. Plus, banks have started lending again, but debt is still “very much limited”, available “only on the right assets to the right principal”. The residential market is also recovering, with prices for well-located properties rising over 20 percent last year. But retail is still under pressure, with rents continuing to fall, albeit at a slower pace. 26 Emerging Trends in Real Estate® Europe 2014

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